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What happens when the stock market gets really expensive really fast: Morning Brief

Sam Ro
Managing Editor

Monday, January 13, 2020

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An expensive market is no reason to turn bearish on stocks

Last year, the stock market had an extraordinary 29% surge that came with valuations expanding far above their historical averages.

According to data compiled by FactSet, the forward 12-month price/earnings (P/E) multiple for the S&P 500 is 18.4, which is well above its 5-year average of 16.7 and its 10-year average 14.9.

Understandably, this probably has some investors nervous about staying in the market or committing new capital to it.

As history shows, price moves and valuations are not very reliable at accurately predicting what happens in the stock market over the next 12 months.

Though, the limited amount of evidence out there is nevertheless encouraging for folks who benefit when prices go up.

“The S&P 500 P/E multiple increased by more than 4x last year,” UBS strategist Keith Parker said in a note to clients last Thursday. “Interestingly, we find that years following a significant re-rating up in the P/E of more than 1.5x, the index median return has been ~15% with three instances of negative returns.”

It’s yet more evidence that stocks usually go up.

“Thus, history suggests that large increases in the P/E should not necessarily be a headwind,” Parker added.

Expensive stock markets could continue to see prices rise. (UBS)

“However, other factors like earnings and growth should matter more, in our view,” Parker caveated. And to be clear, UBS’s house view is that the S&P 500 will fall to 3,000 by the end of 2020.

It’s another reminder that investing is complicated.

But the message should be clear to Morning Brief readers: just because prices have surged, valuations are high, and the bull market seems old does not mean stocks are doomed to fall. In fact, the opposite is usually the case.

By Sam Ro, managing editor. Follow him at @SamRo

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